If you go back a century or so, banks were your one stop shop for everything.
You went to the bank for your mortgage, savings, checking account, investments and even to store your gold. Anything related to finance — you went to the bank.
For most of humanity, banks have monopolised the financial value chain. But over the past 50 years, this has slowly been disintegrating. The mortgage loan value chain was one of the first to disintegrate, with mortgage specialists turning up and suddenly taking care of the servicing, brokering and originating of the mortgages.
It’s only in the past decade or so that we’re seeing the disintegration of other parts of the value chain: investments, savings accounts, and even deposits.
With modern day financial technology such as APIs and Open Banking, it seems that vertical disintegration is the natural course of the financial services industry as firms decide to specialise in areas where they have a competitive advantage.
In this article, we’ll be looking at why this is the case, the role of fintech and what might happen to banks in the future.
The issue with modern-day banking
Banks have been a foundational pillar of modern day society since the time of the Ancient Greeks.There is no denying that they have been instrumental to getting us through wars, implementing monetary policy and allowing people to own homes and start businesses.
But in 2021, banks look a lot different and are a lot bigger. In fact, they have become so big that inefficiencies are starting to form in many of the services they offer. In this article, we specifically want to look at the cost of legacy systems, the financing gap with SMEs, and the rise of competitive fintech.
Opening a bank account nowadays is often an unnecessarily laborious project. In the Netherlands, for example, it often takes 3 months for a business to set up a bank account in a bank.
Modern day consumers are used to the likes of Amazon and Google, so filling out online applications and taking days to open an account is no longer considered acceptable. Why is this happening? The lengthy onboarding processes and time-consuming applications are often due to the legacy systems banks need to contend with in order to offer better customer experiences and upgrade their technology stack.
Although banks are some of the institutions with the largest amounts of data, their legacy systems make it hard to organise, analyse and make decisions based on what they’ve gathered. This puts them at a disadvantage in a world increasingly reliant on data analytics, AI and financial data sharing.
This is also reflected in SME financing. SMEs are still the backbone of European economies, and yet most SMEs feel unsupported in the current financial environment. Current day SMEs that are searching for financing with a bank are often faced with product complexity, strict requirements and confusing terms. According to Close Brothers, ⅓ of SMEs in the UK have been turned down for finance, and this is echoed in other countries across Europe.
When it comes to the funding gap, banks need to adapt to modern day technologies in order to offer financing. This means looking beyond standard measures such as cash flow, and offering products that are more adept to the economic needs of small businesses.
Finally, the rise of fintech and other consumer centric tech apps means that customers are now switching banking providers. Modern day consumers are digital natives that are used to a certain standard of customer experience and service. Many of these digital natives are also from a generation that believes that they should be catered to, and that if an industry doesn’t work, it’s the industry that needs to change.
That’s because technology puts the customer in control: suddenly, the customer can do research, read reviews, compare and decide to switch products. By its definition, then, fintech has a large focus on customer centricity. It’s what allows fintechs to do a much better job at identifying unmet SME banking needs as well as consumer needs.
Instead of trying to be a one stop shop for all services, fintech focuses on creating a simple, well-delivered solution that meets a very specific need.
In the UK, fintech company Kabbage and ING bank partnered up and implemented a solution that allows business clients to borrow €100,000 in a few minutes. Having a light tech stack and customer centric approach means fintechs can outmanoeuvre many of the banks and compete. This is unheard of in the commercial banking world.
1. Customer first mindset
Historically, banks have adopted a product-led approach. They do some research, implement a new feature and then push it into the market. It’s a top-down approach where the people at the top decide what features to implement first.
Fintechs take a different, bottoms up approach: they put themselves in the mind of the customer, and completely reimagine the customer journey. Features are built to meet a specific demand. Where banks focus on building an amazing mortgage, fintech companies understand that a mortgage is just a means to an end — the customer doesn’t want an amazing mortgage, they want a house they love.
A great example to illustrate the difference in approaches is overdraft charges: most banking customers would rather have their bank decline a payment rather than pay overdraft fee and get a negative balance. However, most modern-day banks will still charge an overdraft fee since their priority is catering to shareholder needs.
Fintech neobanks take a different approach. Instead of charging a fee, they will block the payment and warn customers that they don’t have enough in their account. Fintechs try to support and help their customers, where banks simply act as a utility.
2. Faster execution
Fintech companies are organisations with fewer employees, built to be nimble, faster and to execute quickly. They focus on innovation through “two pizza teams”, tight feedback loops and a horizontal structure.
On the other hand, banks still spend 73% of their budget on maintenance, with teams following a hierarchical structure. Banks are incumbent organisations that make it a lot harder to innovate, and therefore execution is slower.
Fintech companies’ ability to execute quickly means they can launch new features, test new technology and essentially deliver customer needs more efficiently.
Many banks still try to be that one stop shop for everything related to finance. Although there will always be customers who want a one-stop shop for everything, many of the modern day digital natives prefer specialised services that are higher quality, offer better customer service and integrate well with other specialised services.
This is the final straw in the disintegration of the value chain: if five integrated specialists do a better job than one communal shop, the value chain as we know it will disappear. We are seeing this happen in modern day financials, where the customer experience is made up of companies such as Adyen managing payments, Onfido taking care of KYC or Revolut offering checking accounts.
What will happen to banks?
What happens when banks’ main value proposition starts to disintegrate?
People have been predicting the demise of the banks since the 70s, and banks are still going strong. The truth is, banks won’t be disappearing any time soon -- however it is possible that they will look very different in a few decades.
Without innovation or specialisation, banks risk becoming the boring old pipes: deposits on one side, capital allocation on the other. They will essentially become utilities, serving the purpose of the main thing they can do: deposits.
If we want to push this further, we could theorise that since the most profitable parts of the banks - offering loans - will be offered by highly specialised fintechs, many customers will move away from banks. This risks cutting into banks’ balance sheets, and might cause banks to start charging fees on deposits in order to remain profitable. This could further push customers away towards fintech companies.
In the 21st century, we’re seeing the disintegration of the banking value chain as we know it. Now, customers and businesses can work with fintech companies to receive loans and manage their money, bypassing banks. As technology keeps advancing, it’s likely we’ll see fintechs taking the lead or partnering up with banks in order to meet customer needs. Although it’s hard to predict what will happen to banks in 10 years, one thing we can be certain is that those offering the best services will be the ones that prevail.